Dollar General Mulls Bid For Family Dollar; Dollar Tree Drops

By Teresa Rivas

Dollar Tree (DLTR) was falling around 2% at recent check as investors reacted to the possibility that Dollar General (DG) will throw its hat in the ring as a suitor for Family Dollar (FDO), whose shares are ahead 2%.

While Family Dollar agreed last week to be acquired by Dollar Tree for $8.5 billion at the behest of activist investors Nelson Peltz and Carl Icahn, this afternoon Bloombergreported that Dollar General is in talks with banks to offer a counterbid, according to anonymous sources close to the company. They say that Dollar General, which previously passed on an opportunity to purchase Family Dollar, has had second thoughts at the notion that it would be bought out by another firm—although there’s no guarantee it will make an offer.

From the report:

The combination of Family Dollar and Dollar Tree — the No. 2 and No. 3 dollar store chains — would leapfrog Goodlettsville, Tennessee-based Dollar General in number of stores to become the largest. With more similarities to Family Dollar, Dollar General may be able to extract even greater benefits from a takeover than Dollar Tree through cost cuts, according to Poonam Goyal, a senior retail analyst for Bloomberg Intelligence.

Some on the Street might be happy to see the deal disrupted. FBR & Co.’s Dutch Fox wrote in a note last week that the Dollar Tree-Family Dollar deal wasn’t good for shareholders: “We view the longer-term success of this potential merger as a question of risk and reward, and we are unconvinced that shareholders are being properly rewarded for the risk that the company is taking on by merging with Family Dollar. In this note, we detail a full four-year P&L/cash flow/balance sheet accretion analysis and a comparative “go/no-go” analysis. Based on our analysis, Dollar Tree can generate a 19.8% EPS CAGR by successfully integrating Family Dollar, which is excellent in the current retail environment. However, we believe the decision to acquire Family Dollar should not be viewed in a vacuum and should be viewed against the backdrop of maintaining the status quo (steady sales growth and aggressive share repurchases), which could generate an 18.5% EPS CAGR. In this light, we are very concerned about the incremental shareholder risks that we believe this merger will generate. With respect to the equities, we believe that FDO and DG have the best optionality, and DLTR may see some selling pressure over the next several months as the shares undergo a fairly significant hand-off between investors.”

Likewise, MKM Partners’ Patrick McKeever declared himself “lukewarm” on the deal and thought a merger with Dollar General would have more synergies: “Dollar Tree operates ~5,100 stores to Family Dollar’s 8,200-plus and did $7.8 billion in sales LY vs. Family Dollar’s $10.4 billion. Post-acquisition, we expect Dollar Tree to operate about 13,500 stores and generate sales of close to $20 billion and about $2.2 billion in EBITDA on an annualized basis, prior to any synergies. The deal is expected to be accretive to Dollar Tree’s cash EPS by a low-mid-single-digit percentage in the first year and generate $300 million in annual run-rate synergies by the end of the third year. While these are compelling economics, we saw synergies of $500-$700 million in a DG/FDO combination (as detailed in recent reports), even though we didn’t expect Dollar General to bid for Family Dollar.”

However, Deutsche Bank’s Paul Trussell recently found himself warming to the deal: “Following flattish performance last week (due in part to significant shareholder turnover), we believe investors have begun to dig into the details of the opportunity DLTR has to transform its business with the FDO transaction. Specifically, we hosted a bull/bear lunch Monday to discuss the deal and walked away sensing a more constructive view than we expected as investors believed (1) the outlined $300M in synergies is attainable, (2) productivity improvements to FDO are possible, presenting upside, and (3) despite execution risks, DLTR should be rewarded for the aggressive use of b-sheet. In our view, DLTR is now one of the more intriguing names in retail.”

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